Saudi Arabia's King Salman has approved a new bankruptcy law. {Download Saudi BK final 2-2018} Commentators have heralded this new law as a boost to economic reforms, in particular to the SME sector, but I have some serious doubts about this. A member of the Shura Council, the King's advisory body, is quoted in one report as explaining "[t]he idea is to simplify and institutionalise the process of going out of business so new organisations can come in." That latter part--new businesses coming in--requires individual entrepreneurs, either the one whose business just failed or new ones, to embrace the major risks of starting a new venture. In either event, a crucial aspect of an effective SME insolvency law, and I would argue THE most crucial aspect, is a fresh start for the failed entrepreneur (and a promise of such a fresh start for potential entrepreneurs). This fresh start is promised and delivered most effectively by provision conferring a discharge of unpaid debt. The new Saudi law all but lacks this key provision. Article 125 on the bottom of page 50 is quite clear about this: "The debtor's liability is not discharged ... for remaining debts other than by a special or general release from the creditors." It seems highly unlikely to me that creditors will offer such releases with any frequency. Yes, the new law provides a useful framework for negotiating restructuring plans, and the Kingdom deserves praise and respect for finally adopting such a measure. But the lack of a law- imposed discharge following liquidation when creditors are not willing to agree is not a foundation for a thriving SME recovery (though I understand and respect the reason why the Saudi law lacks an imposed discharge). Most SMEs are not enterprises--they are entrepreneurs; they are people, not businesses. Leaving these people to bear the continuing burden of unpaid debt does not, in my mind, reinvigorate failed entrepreneurship or entice others to join the movement. I'm afraid the effects on the SME sector of this law will be muted at best. I hope I'm wrong.

If you think it's ridiculous that the CDC can't gather data on gun violence, consider the financial regulatory world's equivalent: S.2155, formally known as the Economic Growth, Regulatory Relief, and Consumer Protection Act, but better (and properly) known as the Bank Lobbyist Act. S.2155 is going to facilitate discriminatory lending. Let me say that again. S.2155 is legislation that will facilitate discriminatory lending. This bill functionally exempts 85% of US banks and credit unions from fair lending laws in the mortgage market. Support for this bill should be a real mark of shame for its sponsors.

As many Credit Slips readers will know, chapter 11 venue reform has been an issue for decades. As corporate filers have flocked to the Southern District of New York and the District of Delaware, the real reason some observers say is that these courts favor corporate managers, dominant secured lenders, bankruptcy attorneys, or a combination of all of them. Regardless of the merits of these claims, it certainly undermines respect for the rule of law when faraway federal courts decide issues affecting local interests. A great example comes from right here in Champaign, Illinois, where local company Hobbico has recently filed chapter 11. The company, a large distributor of radio-control models and other hobby products, has more than $100 million in debt. The company has over 300 employees in the Champaign area who own the company through an employee stock ownership plan. Yet, the company's fortunes are now in the hands of a Delaware bankruptcy court.

I have a new (short!) paper out, Bankruptcy's Lorelei: The Dangerous Allure of Financial Institution Bankruptcy. The paper, which builds off of some Congressional testimony from 2015, makes the case that proposals for resolving large, systemically important financial institutions in bankruptcy are wrongheaded and ultimately dangerous. At best they will undermine the legitimacy of the bankruptcy process, and at worst they will result in crash-and-burn bankruptcies that exacerbate financial crises, rather than containing them. The abstract is below.

The idea of a bankruptcy procedure for large, systemically important financial institutions exercises an irresistible draw for some policymakers and academics. Financial institution bankruptcy promises to be a transparent, law- based process in which resolution of failed financial institutions is navigated in the courts. Financial institutions bankruptcy presents itself as the antithesis of an arbitrary and discretionary bailout regime. It promises to eliminate the moral hazard of too-big-to-fail by ensuring that creditors will incur losses, rather than being bailed out. Financial institutions bankruptcy holds out the possibility of market discipline instead of an extensive bureaucratic regulatory system.

This Essay argues that financial institution bankruptcy is a dangerous siren song that lures with false promises. Instead of instilling market discipline and avoiding the favoritism of bailouts, financial institution bankruptcy is likely to simply result in bailouts in bankruptcy garb. It would encourage bank deregulation without the elimination of moral hazard that produces financial crises. A successful bankruptcy is not possible for a large financial institution absent massive financing for operations while in bankruptcy, and that financing can only reliably be obtained on short notice and in distressed credit markets from one source: the United States government. Government financing of a bankruptcy will inevitably come with strings attached, including favorable treatment for certain creditor groups, resulting in bankruptcies that resemble those of Chrysler and General Motors, which are much decried by proponents of financial institution bankruptcy as having been disguised bailouts.

The central flaw with the idea of financial institutions bankruptcy is that it fails to address the political nature of systemic risk. What makes a financial crisis systemically important is whether its social costs are politically acceptable. When they are not, bailouts will occur in some form; crisis containment inevitably trumps rule of law. Resolution of systemic risk is a political question, and its weight will warp the judicial process. Financial institutions bankruptcy will merely produce bailouts in the guise of bankruptcy while undermining judicial legitimacy and the rule of law.

The lives of Puerto Rico residents remain profoundly disrupted by the aftermath of Hurricane Maria measured by metrics such as electricity, clean water, and health care access, with death tolls mounting. This week, though, in a federal court hearing on January 10, 2018, Puerto Rico has the extra burden of confronting Hurricane Aurelius.

For the spring semester, I am offering advanced commercial law and contracts seminar for UNC students, and have gathered resources to inspire students on paper topic selection as well as to guide what we otherwise will cover. But given the breadth of what might fit under the umbrella of the seminar's title, the students and I would greatly benefit from learning what Credit Slips readers see as the pressing issues in need of more examination in the Uniform Commercial Code, the payments world, and beyond. Some students have particular competencies and interests in intellectual-property and/or transnational issues, so specific suggestions in those realms would be terrific. Comments are welcome below or you can write us at bankruptcyprof <at> gmail <dot> com.

We also are going to do a wiki of commercial law jargon/terminology. So please also toss some terms our way through the same channels as above (or Twitter might be especially useful here: @melissabjacoby).

Ted Janger and I have posted a paper of interest to Credit Slips readers called Tracing Equity. We still have time to integrate feedback, so please download it and let us know what you think.

As the image accompanying this post suggests, the project was inspired in part by recommendations of the American Bankruptcy Institute's Chapter 11 Commission. Discussion of those proposals starts on page 51 of the PDF.

One of the main insights of Tracing Equity is that both Article 9 of the Uniform Commercial Code and the Bankruptcy Code distinguish between (1) lien-based priority over specific assets and their identifiable proceeds, and (2) unsecured claims against the residual value of the firm. By our reasoning, even attempts to obtain blanket security interests do not give secured lenders an entitlement to the going-concern and other bankruptcy-created value of a company in chapter 11. We explain why our read of the law is normatively preferable and, indeed, is baked into corporate and commercial law more generally--part of a large family of rules that guard against undercapitalization and judgment proofing.

A historic vote was announced overnight that signals a new era for large pension reform. As is often the case, "reform" here means that ordinary, hard-working folks will suffer a significant amount of pain as big companies are relieved of some liabilities, but the hope is it will be less painful than the alternative. The revolution began in 2014, when Congress adopted the Multiemployer Pension Reform Act (MPRA). The Pension Benefit Guaranty Corporation guarantees a portion of the benefits due to participants in pension plans that have become insolvent, but as a result, it is also facing a nearly $100 million shortfall in its ability to cover the projected volume of its existing guarantees. Congress attempted to avert disaster by allowing particularly large and especially distressed pension funds to slash benefits themselves in order to maintain solvency. Ordinarily, this extraordinary action would, if possible at all, require an insolvency filing and court oversight of some kind, but the MPRA allows plans who aggregate benefits for many companies (multiemployer plans) to apply to the Treasury Department for administrative permission to abrogate their pension agreements and cut benefits with no court filing or general reorganization proceeding. There are, of course, restrictions on the level of distress required for such a move and the degree of proposed cuts, but the MPRA allows large pension funds to reduce the pension benefits of thousands of beneficiaries with simple administrative approval. The plan participants get a vote on such proposals, but the law builds in a presumption: Treasury-approved cuts go into effect unless a majority of plan beneficiaries votes to reject the cuts.

Guess who’s sponsoring legislation to facilitate predatory lending? It’s not just the usual suspects from the GOP, but it looks like a number of centrist “New Democrats” are signing up to help predatory financial institutions evade consumer protections.

Yup, you heard me right: Democrats. Ten years after the financial crisis, it seems like we’ve gone back to the mistakes of the Clinton years when centrist Democrats rode the financial deregulatory bandwagon. What I’m talking about is the McHenry-Meeks Madden “fix” bill, the “Protecting Consumers’ Access to Credit Act of 2017”. The bill effectively preempts state usury laws for non-bank finance companies like payday lenders in the name of ensuring access to credit, even if on extremely onerous terms.

Right now there's only one Democratic co-sponsor, but others seem to be preparing to join in. They shouldn't, and if they do sign onto this bill, it should only be in exchange for some solid consumer protections to substitute for the preempted state usury laws. This bill should be seen as a test of whether New Democrats "get it" about financial regulation. I'm hoping that they do. If not, perhaps its time to find some new Democrats.

I'm testifying before the Senate Banking Committee this week about "Fostering Economic Growth: The Role of Financial Institutions in Local Communities". It's the undercard for the Comey hearing. The big point I'm making are that the problem is not one of economic growth, but economic distribution. While the US economy has grown by 9% in real terms since Dodd-Frank, real median income has fallen by 0.6%. That's pretty grim. The gains have all gone to the top 10% and particularly the top 1%.

None of the various deregulatory proposals put forward by the financial services industry have anything to do with growth, and they have even less to do with ensuring equitable growth. For example, changing the CFPB from a single director to a commission or switching examination and enforcement authority from CFPB to prudential regulators shouldn't have anything to do with growth. It's a reshuffling of regulatory deck chairs.

The banking industry has been doing incredibly well since Dodd-Frank, outperforming the S&P 500, for example. You'd never know it, however, from their trade association talking points. It really takes a certain kind of chutzpah to demand the repeal of consumer protection laws and laws designed to prevent the privatization of gains and socialization of losses when you are already doing so much better than the typical American family.

House Financial Services Committee Chairman Jeb Hensarling (R-Texas 5th) has an alternative fact problem. In a Wall Street Journal op-ed Hensarling alleged that "Since the CFPB’s advent, the number of banks offering free checking has drastically declined, while many bank fees have increased. Mortgage originations and auto loans have become more expensive for many Americans.”

The problem with these claims? They are verifiably false. Free checking has become more common, bank fees have plateaued after decades of steep increases, and both mortgage rates and auto loan rates have fallen. One can question how much any of these things are causally related to the CFPB, but using Hensarling's logic, the CFPB should be commended for expanding free checking and bringing down mortgage and auto loan rates. Hmmm.

Below the break I go through each of Chairman Hensarling's claims and demonstrate that each one is not only unsupported, but in fact outright contradicted by the best evidence available, general FDIC and Federal Reserve Board data.

The European Commission has just released its proposal for another Insolvency Directive, finally tackling the very sticky issue of substantive harmonization. I had hoped the Directive would push Member States toward greater harmonization of their consumer insolvency regimes, and I even made some proposals for principles and rules for such a move, but because cross-border lending to individuals for personal consumption remains quite limited in Europe (only about 5% of total household lending), the Commission concluded that "the problem of consumers' over-indebtedness should be tackled first at national level." (p. 15) Nonetheless, the Commission's explanatory memo heartily endorses applying the principles on discharge in this new Directive (principally, providing a full and automatic discharge after a maximum 3-year process) to all natural persons, both entrepreneurs and consumers.

As to the former, though, the proposed Directive virtually shoves European national insolvency law in the direction of US law--for better or worse. The primary thrust is to encourage a rescue climate through more robust "preventive restructuring frameworks." Read: Chapter 11. The characteristics of such frameworks include leaving the debtor in possession of its assets and affairs, staying enforcement proceedings that might interfere with restructuring negotiations, mandating disclosures for proposed restructuring plans, facilitating plan adoption by creditors in classes, including a cram-down option and an explicit absolute priority rule (pp. 30, 38, not mentioning a new value corollary ... though not using the troublesome phrase "on account of its claim" in the definition of the absolute priority rule), and protecting new (DIP) financing. The importance of institutions is highlighted, with mandates concerning the expertise and training of judges, administrators, and practitioners. A few Credit Slips contributors in particular might be interested in the Commission's comment that "It is important to gather reliable data on the performance of restructuring, insolvency and discharge procedures in order to monitor the implementation and application of this Directive." The proposal thus includes detailed rules on data to be collected using standardized templates for easy comparison of empirical results across countries.

My sense is that this proposal will face some substantial political opposition, but the Commission has an impressive track record on getting its proposals adopted by the Parliament and Council. If and when this thing is adopted, I'm sure European authorities will have no trouble finding US restructuring professionals eager to volunteer to visit Europe to provide the type of training to judges, administrators, and practitioners mandated by this Directive. Put my name on the list!

A common argument made against regulating small dollar credit products like payday loans is that regulation does nothing to address demand for credit, so consumers will simply substitute their consumption from payday loans to other products: overdraft, title loans, refund anticipation loans, pawn shops, etc. The substitution hypothesis is taken as a matter of faith, but there's surprisingly little evidence one way or the other about it (the Slips' own Angie Littwin has an nice contribution to the literature).

The substitution hypothesis is prominently featured in a New York Times piece that is rather dour about the CFPB"s proposed payday rulemaking. Curiously, the article omits any mention of the evidence that the CFPB itself has adduced about the substitution hypothesis. The CFPB examined consumer behavior after banks ceased their "deposit advance programs" (basically bank payday lending) in response to regulatory guidance. There's a lot of data in the report, but the bottom line is that it finds little evidence of substitution from DAPs to overdraft, to payday, or even to bouncing checks. The one thing the CFPB data examine is substitution to pawn shop lending. A recent paper by Neil Bhutta et al. finds evidence of substitution to pawn lending, but not to other types of lending, when payday loans are banned. I'd suggest that we're more likely to see a different substitution: from short-term payday loans (45 days or less) to longer-term installment loans. That's not necessarily a bad thing...if the regulations are well-crafted to ensure that lenders aren't able to effectively recreate short-term payday loans through clever structuring of installment loans. For example, a lender could offer a 56-day loan with four bi-weekly installment payments, but with a "deferral fee" or "late fee" offered for deferring the first three bi-weekly payments. That's the same as four 14-day loans that rollover, and the "late fee" wouldn't be included in the APR. That's perhaps an even better structure for payday lenders than they currently have.) The bigger point here is this: even if we think that there will be substitution, not all substitution is the same, and to the extent that the substitution is to more consumer-friendly forms of credit, that's good.

H.R. 5278, containing debt restructuring authority and an oversight board for Puerto Rico, inched closer to passage after yesterday's approval by the House Natural Resources Committee. A combination of Rs and Ds rejected amendments that would have unraveled the compromise (scroll here for the amendments and their fates). They indicated an appreciation for the automatic stay, for the downsides of exempting classes of debt from impairment, and even for the assumption of risk taken by recent bond purchasers (bond disclosures quoted!). The discussion reflected the creditor-versus-creditor elements of the problem and the need for a legal mechanism to discourage holdouts and encourage compromise. Even though they have been asked not to call it "bankruptcy" (or to say "control board"), it was clear they know the restructuring provisions come from Title 11 of the U.S. Code.

Given that derivation, many judges on the merit-selected bankruptcy bench could admirably handle the first-ever PROMESAnkruptcy, drawing on their directly-relevant experiences with large chapter 11s, if not chapter 9s.

But section 308 of H.R. 5278 prevents that, and the Natural Resources Committee, in light of its jurisdiction, may not have been in the best position to appreciate the resulting risks.

Lawless reminds us of the risks associated with discriminatory treatment of Puerto Rico's debt and access to legal tools. Of course, there is a long history here. Maria de los Angeles Trigo points to UT professor Bartholomew Sparrow's study of the Insular cases. And while most expect debt relief will be conditioned on some sort of fiscal oversight, it needs to be designed in a way to avoid the foibles of the past.

Returning to Lubben's mediation theme, let's push the brainstorming a step farther: could Treasury appoint a federal judge, such as Chief District Judge Gerald Rosen (E.D. Mich.), to oversee the mediation, and demand that all creditors participate in good faith until released? Even in the absence of legal authority for this move, would creditors formally object or fail to show up?

Thanks to participants and readers for active involvement so far, and please keep your thoughts and reactions coming this way.

Former Virginia Congressman M. Caldwell Butler died last week. He is widely known for his role in the Nixon impeachment proceedings, his efforts to limit extensions of the Voting Rights Act, and his support for ensuring legal representation for low-income individuals. But Congressman Butler is also a major figure in the history of bankruptcy law. He was a principal co-sponsor of the Bankruptcy Reform Act of 1978 that serves as the foundation of the modern bankruptcy system. Professor and lawyer Kenneth N. Klee worked closely with Congressman Butler on the House Judiciary Committee in the 1970s. I asked Professor Klee to share a few words of remembrance with us, which I repeat in their entirety here:

I first met M. Caldwell Butler in 1975 when he became the Ranking Minority Member of the Subcommittee on Civil and Constitutional Rights of the House Judiciary Committee. Caldwell was most interested in the Voting Rights Act legislation and finding a way for the South to get out from under the Act. In his view, Washington was improperly interfering with the sovereignty of the southern states based on predicate acts that had long since ceased to serve as a basis for federal control. He asked me to draft a series of amendments that would permit the South to extricate itself from the Voting Rights Act. The requirements to regain sovereignty were quite demanding, to the point that the amendments became known as the "impossible bailout." Nevertheless, the amendments did not come close to passing. It was evident that there were no circumstances under which the majority in Congress wanted to let the southern states out from the Voting Rights Act.

Caldwell assumed his responsibilities over bankruptcy legislation with diligence and good cheer. His fabulous sense of humor carried us through many long markup sessions during which the members of the Subcommittee read the bankruptcy legislation line by line. He had a sharp legal mind and deep curiosity. He also was very practical and to the point. He was fond of telling me "don't give me so much that you've given me nothing."

It was a privilege and honor to work with him. The bankruptcy community should join in paying him tribute.

-- Ken Klee

Congressman Butler made another round of contributions to bankruptcy reform in the 1990s. The fact that they are not all reflected in today's Bankruptcy Code makes this story more pressing, not less. Well over a decade after he had returned to the practice of law in Virginia, Congressman Butler was appointed to the National Bankruptcy Review Commission, for which I was a staff attorney. Expressing satisfaction with the 1978 Code, the House Judiciary Committee directed this Bankruptcy Commission to focus, for two years, on "reviewing, improving, and updating the Code in ways which do not disturb the fundamental tenets of current law." Not one to leave the heavy lifting to others, even in a pro bono post, Congressman Butler stepped up to the challenge of forging a compromise, among those with diverging politics and views, to improve the consumer bankruptcy system.

At today's House Judiciary Committee hearing on Operation Choke Point it seemed that Choke Point's critics are conflating a fairly narrow DOJ civil investigation with separate general guidance given by prudential regulators. In particular, Rep. Issa attempted to tie them together by noting that the DOJ referenced such guidance in its Choke Point subpoenas, but that's quite different than actually bringing a civil action on such a basis (or on the basis of "reputational risk"), which the DOJ has not done.

There is a serious issue regarding the bank regulators' use of "guidance" to set policy. Guidance is usually informal and formally non-binding, but woe to the bank that does not comply--regulators have a lot of off-the-radar ways to make a bank's life miserable. This isn't a Choke Point issue--this is a general problem that prudential bank regulation just doesn't fit within the administrative law paradigm. There are lots of reasons it doesn't and perhaps shouldn't, but when it is discovered by people from outside of the banking world, it seems quite shocking, even though this is how bank regulation has always been done in living memory: a small amount of formal rule-making and a lot of informal regulatory guidance. By the same token, however, compliance with informal guidance is enforced informally, through the supervisory process, not through civil actions, precisely because the informal guidance is not actionable. Yet, that is what Choke Point critics contend is being done--that DOJ is using civil actions to enforce informal guidance.

I don't think that's correct (or at least it hasn't been shown). But the conflation of DOJ action with prudential regulatory guidance may be creating the very problem Choke Point's critics fear.

Bank compliance officers may be hearing what Choke Point critics are saying and believing it and acting on it. If compliance officers believe that the DOJ will come after any bank that serves the high-risk industries identified by the FDIC or FinCEN, not just those that knowingly facilitate or wilfully ignore fraud, they will respond accordingly. The safe thing to do in the compliance world is to follow the herd and avoid risks. The attack on Operation Choke Point may well have spooked banks' compliance officers, who'd aren't going to parse through the technical distinctions involved.

What matters is not what the DOJ actually does, but what compliance officers think the DOJ is doing, and they're likely to head the loudest voice in the room, that of Choke Point's critics. So to the extent that we are having account terminations increasing after word got out of Operation Choke Point it might be because of Choke Point's critics' conflation of a narrowly tailored civil investigation with broad prudential guidance. Ironically, we may have a self-fulfilling hysteria whipped up by Choke Point critics, who shoot first and ask questions later.

The fast-moving legislation's title does not include the word bankruptcy. Materials distributed by the Puerto Rico government explain, though, that the bill is meant to provide chapter 9-like relief to Puerto Rico public corporations through one of two paths - one more prepack-like than the other. Calling the effort "dazzling," Cate Long notes, "[s]eldom have financial markets seen such an elegantly choreographed approach to haircutting sovereign debt."

However elegant, investors say the bill violates multiple provisions of the U.S. Constitution. Quiz yourself, or directly check out the action just filed in the U.S. District Court for the District of Puerto Rico seeking a declaratory judgment. H/T Cate Long.

Chapter 15’s modified universalism structure requires cooperation between courts in different countries as well as tolerance for outcome differences under different bankruptcy laws. While in general it’s fair to say U.S. courts have been cooperative and tolerant, for some reason the issue of intellectual property licenses in bankruptcy brings out the worst in us.

In the appeal of Jaffe v. Samsung (the appeal of a case called In re Qimonda in the courts below), the Fourth Circuit recently held that a U.S. bankruptcy court can require a German court overseeing the liquidation of a German company to apply U.S. law when dealing with licenses of U.S. patents.

Congress is considering amending Chapter 15 to mandate a similar result through the proposed Innovation Act, which would add the following language to Section 1522:

In Russia, a debate is raging over which courts should administer consumer bankruptcy cases, the specialized commercial courts or the courts of general jurisdiction. The Russian commercial courts (Arbitrage courts) currently exercise jurisdiction over bankruptcies of individual small business people, as well as over cases involving artificial legal entities like corporations. Logically, then, in the current bill that would finally expand the Russian bankruptcy system to provide relief to consumers, the Arbitrage courts would handle such cases.

Oddly, President Putin in March issued an edict strongly suggesting that the bill be amended to assign jurisdiction to the general courts. The Supreme Court had already come down solidly on the side of the generalist courts, and in April, it threw its support behind Putin’s edict by introducing a bill into the legislature to amend the Code of Civil Procedure to preemptively assign consumer bankruptcy jurisdiction to the general courts, if and when a consumer bankruptcy bill ever becomes law. The explanatory notes to this bill make what seems to be a rather superficial and formalistic argument about consumer contracts “not bearing an economic character,” since they relate only to personal consumption, and noting that consumer cases will raise all manner of non-economic issues, such as family, housing, and labor, which the Arbitrage courts are ill-situated (if not constitutionally forbidden) to address. The next thing you know, they’ll introduce a distinction between “core” and “non-core” matters—that will really fire things up!

Judging by an Irish Times report today, the designers of the new Irish consumer insolvency system seem to be falling into two old familiar traps.

First, the focus of the story is on rumors that the proposed income guidelines for the new regime will make payment plans too parsimonious. Pressing debtors too hard in the name of "responsibility" is a recipe for disaster, as administrators of the French system learned decades ago. A discharge is a nice incentive to get debtors to really exert themselves for the benefit of creditors, but five or six years on an overly repressive budget will produce plan failure, all but guaranteed. Paul Joyce, Senior Policy Researcher at the Irish Free Legal Advice Centres (and an absolute prince of a guy) pointed out this danger in his fine policy analysis of the new regime. It will be a shame if the soon-to-be-released guidelines fail to heed Paul's and others' warnings.

A prior post addressed a proposed amendment to Article 9's official comments stating that the date of an Article 9 filing relates back to the initial filing date even if the debtor did NOT authorize the filing at that time. This post returns to that topic for two reasons. First, although it is risky to generalize, I sense that bankruptcy judges may still be unaware of this proposed amendment. This is relevant because bankruptcy judges often are on the "front lines" of Article 9 interpretation. Second, I have heard, indirectly, that at least some people want this amendment to lend approval to some lenders' current practice to routinely file without authorization during the loan application process. In other words, the loan is likely to be given within a few days, so no harm no foul. Maybe I misheard or misunderstood?

When the debtor's signature was eliminated as a requirement for a valid financing statement in Revised Article 9, the drafters justified the change by technology: medium neutrality and facilitating paperless filing. Functionally, though, the implications go far beyond technology when you combine this change with the opportunity to file all-asset financing statements AND the broadest possible reading of the first to file or perfect rule discussed a few weeks ago.

On January 1, 2011, Larry files a UCC-1 financing statement against David indicating David's equipment as collateral. At this point, David doesn't even know Larry, has not given him a security interest, and has not authorized this filing. On February 1, 2012, David meets and borrows money from Larry and signs a security agreement listing equipment as collateral (which, under UCC 9-509, automatically authorizes the filing of a financing statement against equipment). What is the relevant date for determining Larry's priority? The language of Article 9 itself strongly implies that February 1, 2012 is the relevant date. UCC 9-509 makes clear that financing statements are not valid unless authorized by the debtor - a pretty minimal burden to cloud the debtor's title. But a little-discussed 2010 amendment to the official comments of Article 9 says otherwise: to the drafters, if the filing is later authorized, Larry gets the benefit of the 1/1/2011 filing date for purposes of the "first-to-file-or-perfect" rule and other priority rules or competitions.

The most relevant portion of the new paragraph (an addition to comment 4 to 9-322) reads as follows:

In many respects, bankruptcy is a one-size-fits-all legal process. Yes, there are ample differences in the law (and a world of difference in practice) between the bankruptcy of a large corporation and a typical consumer. But the Bankruptcy Code itself contains plenty of provisions of general applicability. A major example of the one-size-fits-all approach to bankruptcy is the official forms for filing a case. The basic petition and schedules are the same forms for Big Airline Co. and Mr. Joe Blow. The information on the forms is wildly different, with Big Airline Co. listing hundreds or even thousands of creditors, with many more digits in their debts, than Joe Blow. But the form for those debts--Schedule F--is the same form. That may all be changing soon.

The Bankruptcy Rules Committee began a Forms Modernization Project a few years ago, and one of its top agenda items has been creating new forms just for use in consumer bankruptcy cases. Although few people seem to be aware of the effort, a draft version of those new forms is available to the public and to my mind, well worth a look. To see the forms, go here, then click on September 2011, download the file, and look at pp. 189-315 of the PDF (or tab 7.1 if you use the PDF index.) One thing that is obvious from the page numbers in the prior sentence is that the new forms are really long--way longer than the current forms as completed in the typical consumer case. The added length results in part from the development of extensive instructions for each form. Below is an example of a new form with some commentary on its notable new features.

On December 7, 2011, President Obama signed the Federal Courts Jurisdiction and Venue Clarification Act of 2011, H.R. 394, P.L. 112-63. The bill does not amend 28 U.S.C. 1408, the primary venue provision for bankruptcy cases in the U.S. Nonetheless, the changes should make us think again about the propriety of place of incorporation as a basis for chapter 11 venue (hat tip to Elizabeth Gibson, who figured this one out right away).

Tomorrow, Katie Porter and I will be testifying at a subcommittee hearing for the Senate Committee on Banking, Housing and Urban Affairs. The title of the hearing is "Consumer Protection and Middle Class Wealth Building in an Age of Growing Household Debt." More information on the hearing is available here, which is also the same place the written witness statements and a link to streaming video eventually will appear. Part of the discussion will be the conditions that led Congress to create the Consumer Financial Protection Bureau and how those conditions remain with us.

The Consumer Financial Protection Bureau has launched the first project in its "Know Before You Owe" initiative with the release of proposed mortgage disclosures. While the CFPB did its homework in designing these forms, including getting feedback from a wide variety of sources, it is taking field-testing to a new level by asking American consumers to review two proposed forms. Consumers can then vote for the form that they think best conveys the key information needed to understand a home mortgage loan. The choices, named "Azalea" and "Camellia" for the fictional banks on the sample disclosures, are available here. (Simply click to view them as a PDF and then vote for your favorite.)

Channeling my inner Alan White, my Dealbook post this week talks about the politics of expanding chapter 9 and using chapter 11 in place of the Dodd-Frank resolution authority. In short, while I actually support both ideas, with some qualifications, embrace of these by the right as union busting and anti-bailout tools makes it unlikely to happen.

Hello everyone and thank you so much to Bob and Adam for bringing me into this exciting conversation. This week I want to raise with you a few thoughts about the way forward on financial regulation that have come out of interviewing and observing regulators in their interactions with market participants over ten years. My research has been mainly in Japan but involves some US components as well.

Over at Volokh Conspiracy, Todd Zywicki spent Christmas Eve crowing about a Wall Street Journal article about the boom in payday lending. Todd sees the article as vindication for his insistence that regulation of consumer credit will inevitably result in a substitution of another type of credit. For Todd, the substitution hypothesis makes regulation not just pointless, but actually harmful because it will eventually push consumers into the arms of loan sharks.

There are a whole bunch of problems with the substitution hypothesis, as well as for Todd's interpretation of the WSJ article. Todd writes that:

Maybe instead we ought to acknowledge that there will be unintended consequences, such as by making credit cards less available regulation will drive many consumers to substitute to more expensive types of credit, such as payday loans? And just wait until the well-intentioned bureaucrats at the CFPB really start protecting those poor folks, then they are really going to get it.

For starters, Todd doesn't accurately summarize the WSJ article. He implies that it was referring to credit cards in general. It wasn't. It was referring to subprime credit cards. The WSJ article quotes a payday lender as stating, "We believe that we're starting to see a benefit of a general reduction in consumer credit, particularly ... subprime credit cards."

It turns out that subprime credit cards are often as or more expensive than payday loans. The Credit CARD Act severely curtailed a type of subprime card called "fee harvester" cards. A 2007 NCLC study shows that the costs of fee harvester cards rival or exceed payday loans. So if there's substitution here, it might actually be a good thing. The article is certainly not evidence for middle class consumers getting driven into the arms of payday lenders. Instead, at best, it shows some substitution of fringe financial products and it isn't clear that it is harmful substitution.

My latest Dealbook post is up. In it, I argue that the difficulties of cross-border corporate bankruptcy show just how hard it will be to implement a cross-border resolution process, as Dodd-Frank contemplates.

So the fight over leadership of the House Financial Services Committee has begun with an attack on Dodd-Frank, particularly with the claim from Spencer Bachus, one of men who would be chair, that Dodd-Frank would cost the US derivatives industry more than $1 trillion, and drive everyone to London and Zurich -- assuming the regulators in those jurisdictions are siting on their hands, which seems unlikely, but I digress.

The $1 trillion figure comes from ISDA, the industry group that is not particularly known for its measured, balanced approach to derivatives policy. But that's not really the issue -- after all, as long as we acknowledge what ISDA's goals are, they can't really be faulted for pursuing them with great vigor.

But if we're going to embrace ISDA propaganda press releases wholesale, we should at least get the facts straight and understand what is being asserted.

My take, up on Dealbook. I've also authored a comment letter on the topic. The point is not to question the creation of a separate resolution authority -- that's already done -- but to question the creation of a whole new set of rules, that are largely the same but just so slightly different from those applied in chapter 11.

Notary fraud is nothing new, and it's hardly foreclosure-specific. Requiring state courts to recognize out-of-state notarizations would be a significant invasion of the federal government into states' own rules of evidence. It's not equivalen to requiring recognition of other states' judgments. Some jurisdictions, like DC, recognize out-of-state notarizations, but one can easily understand why a state might not: how does a state court in Florida know what a proper Alaska or Hawaii or Vermont notarization looks like or what rules govern notaries in those jurisdictions? Is there supposed to be a seal? What does it look like? Does the signature need to be performed in the notary's presence or merely affirmed? If the notarization is fraudulent, is the out-of-state notary likely to be disciplined?

As loyal Slips readers will no doubt recall, I've been something of a broken record (what's the modern version of that saying? Buggy mp3?) on the issue of the safe harbors in the Bankruptcy Code, especially as expanded by the 2005 Amendments. In short, I believe that that special treatment of derivative contracts is both more likely to increase systemic risk than reduce it, and incredibly overbroad, giving parties an incentive to disguise regular contracts as derivatives to get out of the automatic say and the operation of section 365.

But I wonder if the recently enacted Dodd-Frank financial reform legislation might reduce the temptation to claim that every routine supply contract is actually a protected swap. Under the legislation, a "Major Swap Participant" is subject to new capital and margin requirements, if not otherwise subject to prudential regulation. A big energy company that is routinely arguing in chapter 11 cases that their supply contracts are subject to the safe harbors might back itself into these capital and margin rules, especially given that the definition of "swap" under the reform legislation is quite similar to that under the Code.

I have known Elizabeth Warren for ten years, and I know her pretty well. I've been to her home; she's been to mine. She sent me baby gifts; I got her a 60th birthday present. We exchange Christmas cards, . . . you get the idea.

Now she's a candidate for this big-time appointment as the Director of the New Consumer Financial Protection Bureau. And somehow there are these things about her that must be deep-dark secrets because it seems like people do not know Elizabeth Warren at all. (As Bob Lawless has written, I think the debate is becoming about a caricature of Prof. Warren, not Prof. Warren the real person.) So here it is . . . Secrets about Elizabeth Warren Revealed.

Scholars and industry analysts are currently debating whether the Dodd-Frank Wall Street Reform and Consumer Protection Act – passed on June 30 by the House and pending before the Senate – represents meaningful reform. On one issue, however, the outcome is already clear. The largest banks have defeated provisions that would require them to make a meaningful contribution toward the huge subsidies they receive as "too big to fail" (TBTF) institutions.

Mike Konczal at Rortybomb has an interesting post about the Protecting Gun Owners in Bankruptcy Act of 2010 (the Pro-GOB Act). This legislation would make firearms exempt from creditors' claims in bankruptcy. I'm still not sure if it is a joke or real legislation; I haven't been able to find the text of a proposed bill. Even if one thinks this legislation is a good idea (which it isn't), it is all sizzle, no steak. It would be inapplicable to almost all bankruptcy cases. It would only affect Chapter 7 debtors who own firearms and live in 16 states.

It looks like auto dealers are going to get their carve out from the CFPB. I can't think of a policy argument for exempting auto dealers; maybe someone will provide one in the comments. The used car dealer has long been the poster child for sharp dealing. But it's worth reviewing the consumer protection problems with auto dealers, so that we realize what practices are being exempted from potential future regulatory oversight.

Todd Zywicki and I have been having a back and forth on interchange in several forums. Todd and Joshua Wright had an op-ed in the Washington Times, I responded with a letter to the editor, and then Todd came back with a blog post. I posted a detailed response to Todd in the comments to his post, but I will repost the core of the response here.

In his blog post, Todd says that he can't understand my argument that in the credit card world there are economic rents (supracompetitive prices) being extracted from both merchants and consumers. Todd thinks the only possible economic rents story is one of merchants being charged too much and consumers too little. (Todd does not endorse this story, but he at least gives it theoretical credence.) Therefore, Todd believes that any reduction in interchange income must be offset by an increase in consumer charges.

What follows is a brief outline of my argument that the current credit (and debit) card system simultaneously extracts economic rents from both merchants and consumers. The corollary to my argument is that interchange regulation actually produces reductions in the economic rents paid by both merchants and consumers; it does not result in costs being shifted form merchant to consumer, but instead results in reduce profits for card issuers and card networks. To this end, I present a rough sketch of the net impact of interchange reform in Australia; as surprising as it is, I do not believe this has been done before.

Today the Federal Reserve's Consumer Advisory Council (CAC) has submitted a letter of opposition to the auto-dealer carve-out to Chairmen Frank and Dodd. This letter is an unprecedented move for the CAC, which is a non-partisan, expert body that does not usually weigh in on legislation. I think it shows that there is absolutely no policy justification for the auto dealer carve-out.

Russell Simmons (yes, the hip-hop entrepreneur and vegan advocate) is blogging away at Huffington Post against the Durbin interchange amendment. Simmons claims that his card takes "the poor, the voiceless and the
under-served" out "from the claws of payday lenders and check cashers, from
humiliating
lines waiting to cash their paychecks and then more lines to pay their
bills."

Gosh, you'd think that Russell Simmons was operating a
charity. Somehow Simmons neglects to mention how much money he is pocketing from debit card swipe fees in addition to the $1/transaction "convenience fee" the RushCard charges its low-to-moderate income users. (See here for more details on the RushCard.) The RushCard is an alternative to check-cashing outlets, but that's all that it is--another high-cost financial service for the poor. I'd be curious to know how much revenue the RushCard makes on interchange; I suspect it would still be quite profitable without it. Maybe Russell will show us the books.

Russell Simmons is claiming to be the voice of minority communities and the poor on interchange. He's not, and his personal financial interest in maintaining high interchange rates compromises him as an advocate on interchange, just as the fees on the RushCard compromise him as an advocate for the poor.

It's worthwhile looking at what The Hispanic Institute, which has no financial stake in the matter, found in an empirical study it sponsored on interchange fees. The study finds that there is a regressive cross-subsidy that has a disproportionate negative impact on low income minority communities.

Simmons also misunderstands (perhaps deliberately) the Durbin amendment in his post; he complains that it regulates debit interchange while leaving credit interchange untouched, and that this dings the poor, while leaving the rich unscathed. That's just wrong. While part of the amendment deals only with debit cards, part covers all payment instruments, including permitting merchants to offer a discount for debit (how does that hurt the poor?). The impact of reduced debit card interchange will inevitably be reduced credit card interchange rates for smaller ticket transactions where credit competes with debit.

The logic of the Durbin amendment is straightforward: debit transactions are just like checks, but with even lower fraud risk because of real-time authorization. Checks clear at par throughout the entire banking system. Therefore, debit should clear at par too (or close to it--the amendment is generous in this regard). If debit clears at near par, credit interchange rates will drop, and because merchants are, in general, more price competitive than card issuers, the savings will be largely passed through to consumers. The card industry will have to learn to live with reduced (but still substantial profits), which should incentivize the card industry to innovate to develop new, efficiencies or higher margin products. Net result: consumers win.

The Wall Street Journal has a story that Bank of America is contemplating the end of free checking in response to the paring back of fee income due to regulatory reform. Banks are undoubtedly already adapting to the past year's regulatory changes, and that means attempting to figure out where they can charge new fees or increase existing ones, without losing too many customers so that the net result of the fee structure shift would be a loss.

Yet, I'm dubious that free checking will go the way of the dodo. Here's why:

It's amazing who the interchange debate will bring out of the woodwork. Hip-hop entrepreneur Russell Simmons has been making the rounds on Capitol Hill (and on Huffington Post) urging Congress not to act on interchange reform. Why is Simmons so engaged with this issue?

The answer is because he makes a lot of money off of interchange from a very questionable product. Simmons markets the "RushCard" a Visa-branded prepaid debit product marketed primarily to the black community. The card provides a payment device for an ersatz deposit account, which allows cardholders to make transactions when cash is not accepted. Remember that there is no extension of credit to the consumer on the RushCard. Instead, like any prepaid debit product, the RushCard consumer is actually lending money to Bancorp Bank, the card issuer. And, as we'll see, the consumer is actually paying money to make an interest-free loan to the Bancorp Bank.

Simmon's claim is that the RushCard provides important access to financial services for the unbanked: it's helps consumers avoid check cashing and bank account fees, has greater security than cash, is convenient, and it's "the prepaid card that provides respect."

What's respect worth? Well, take a look at the fee schedule below and decide for yourself.

As the financial reform bills make their way through committee conference, I thought I would take this opportunity to reflect on the activities of private equity firms and hedge funds in bankruptcy. (For those of you interested in the bills’ efforts with respect to credit rating agencies, see my post here at Maryland’s new faculty blog.) Although the financial reform bills provide for some regulation of private funds (see here and here), some argue that the proposed measures are meaningless because of, among other things, exemptions and enforcement issues (see here and here). Others argue that even these measures hinder private funds’ business models (see here). Irrespective of your views on this debate, it is clear that the bills do not address the challenges posed by private funds in the distressed debt context.

Investing in distressed debt is not a new investment strategy, but private funds have been pursing it with increased vigor in recent years. And they have been doing so quite successfully. These funds generally yield above-market returns, and during the 1999-2004 economic bubble/burst, they averaged "double-digit returns, including 30 percent for the 2002 funds." The most recent recession has likewise provided ample opportunity for distressed debt investors. These opportunities are likely to continue for the next several years, as "U.S. companies have about $600bn . . . of leveraged loans to refinance . . . between 2011 and 2014." (See here and here.)

Distressed debt investing generally involves a private fund purchasing the debt of a troubled company and then exploiting the leverage associated with that debt instrument when the company defaults or is about to default on the underlying obligation (see here and here). Some of these investors resemble pure traders and primarily seek to flip the debt for a quick return. Others are, however, using this investment strategy to influence corporate governance or make a control play for the company. (For data on investment strategies, see here.) These investors also are increasingly willing to extend postpetition loans (i.e., DIP financing) to troubled companies, often with the intent to credit bid the debt or otherwise convert it into equity to gain control of the company. As one commentator observed, "Investors in loan-to-own deals may earn an 18 percent return on the financing, plus get equity, compared with the potential for 12 percent returns and no equity on DIPs."

Now, I am not against private funds earning positive returns for their investors—that is of course the primary objective of for-profit endeavors. I also believe that these investors frequently provide much-needed liquidity to troubled companies; liquidity that otherwise would be unavailable and that can provide a second (or third, etc.) chance for the company to the benefit of all stakeholders. I am, however, concerned about the unlevel playing field on which these investors operate in many instances.

Zywicki's interchange paper repeats a claim made by other opponents of interchange regulation that cross-subsidies, even regressive ones, exist throughout the economy, so there's no reason to get worked up over the interchange cross-subsidy imposed by credit card network rules.

Zywicki provides several examples of cross-subsidies in the consumer economy: Starbucks charges the same price regardless of whether a consumer takes sugar and cream, so those who take their coffee black subsidize the sugar and cream of the others. Supermarkets offer free parking, so the walkers subsidize the drivers.

Zywicki's examples, however, are false analogies to the credit card
interchange cross-subsidy from users of low cost payment methods (cash, debit, nonrewards credit) to users of high cost payment methods (rewards credit). The Starbucks' cross-subsidy is Starbucks' business decision. The free parking cross-subsidy is the grocery store's business decision. But the interchange cross-subsidy is not the merchant's business decision. It is the card network's business decision. Card networks force merchants to impose a cross-subsidy. It's an affront to the nose-picking rule of commerce: you can pick your friends, you can pick your prices, but you can't pick your friends' prices....

With this in mind, it's worth examining another cross-subsidy caused by interchange. Interchange fees are paid from acquirers to issuers. The fees are the same for all banks. Therefore, the safer banks are subsidizing the riskier banks in a card network. But there's a catch. The safer bigger banks often get rebates from the card network in addition to interchange fees.

Two interesting points about this. First, it shows that the card networks won't tolerate cross-subsidies for themselves. Second, it casts some doubt on the efficiency rationale for interchange fees--that one-size-fits-all fees are sensible as a way to avoid the transaction costs of individually negotiating every issuer-acquirer contract. Truth is that 20 or so banks make up 95% of the credit card market. The transaction costs for these banks to negotiate with each other is fairly low. This points to the question of whether small banks should be in the card business at all. Cards are very much an economy of scale business; smaller issuers tend to see cards as loyalty devices, not profit centers. Would a 20-bank card market be a more efficient arrangement than the current networks with thousands of institutions? I'm not sure, but I think the efficiency of the interchange system is far from proven.

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As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information.
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